Modest slowdown in premium growth distinguishes second-quarter financial results for MPL specialty insurers
We look at the financial results for medical professional liability (MPL) insurers for the second quarter of 2022.
With the January 2023 effective date of International Financial Reporting Standard (IFRS) 17 fast approaching, (re)insurers are busy making their final refinements and analyses in the remaining window.
One area that is now receiving greater focus is the need for comprehensive validation of IFRS 17 models and results to provide the board and senior management with additional comfort over the results in the new financial statements.
There are new models performing new calculations, such as the Contractual Service Margin (CSM) and Risk Adjustment, at a new level of granularity (portfolio/profitability/cohort groups). There are also new assumptions being determined, such as the IFRS 17 discount rate and the split of expenses between those that are attributable and non-attributable. There are new processes and systems to produce the required presentation of results and disclosures.
Testing of these new elements will generally have been carried out as part of the development process. However, this testing will likely have had a scope that is different from a full validation. Development testing is carried out by the business function and is initially mostly concerned with testing the functionality of calculations. It is generally carried out while models are still being refined and developed and full documentation is usually not in place yet.
Validation testing is much more comprehensive, covering all aspects of the process including inputs, calculations, and outputs, as well as model governance and documentation. A key consideration in validation testing is ensuring that the model and results are conceptually appropriate and fit for purpose. This is particularly important for IFRS 17, which does not have prescribed rules but instead is principle-based and can have different interpretations. Knowledge of general market practice and industry views will be important for this aspect of the validation.
Although the core models for many companies may have already been validated for Solvency II, it is likely that materiality thresholds for IFRS 17 will be lower than for Solvency II, as calculations need to be appropriate for the profit and loss (P&L) statements as well as the balance sheet. In addition, IFRS 17 introduces concepts that are not present in either Solvency II or existing financial reporting such as the new CSM/Loss Component/Loss Recovery Component in the new financial statements, as well as the interaction with Other Comprehensive Income (OCI) that can be used. Additionally, the calculation of the CSM at unit-of-account level (i.e., the intersection of portfolio, profitability and annual cohort) can create challenges in interpreting results, as companies are not used to analysing results at this level.
Model validation testing should be carried out by the function tasked with providing oversight of the IFRS 17 model implementation. This could be completed internally (for example, by the risk function, actuarial function or an independent team within the finance function) or with assistance from an external party. In any case the actuarial function will play an important role in the validation process, as the actuarial function has responsibility for the Solvency II best estimate and its parameters, assumptions, analysis of movement etc., which are often used in preparing the IFRS 17 results.
Companies will have had discussions with their auditors around methodology, accounting choices and entity-specific decisions in advance, but auditor independence normally precludes heavy involvement in model development. Rigorous model validation should be carried out before the first set of financial statement results go to external audit, as this will occur late in the process, making it difficult to make enhancements for any findings at such a late stage. Model validation can also be a useful input to the audit review.
An IFRS 17 model validation exercise could include the following aspects:
Model validation can provide the board and senior management with additional comfort over the results in the new financial statements, and should be an important part of any IFRS 17 project.
More details on the importance of model validation and governance can be found in our briefing note: https://www.milliman.com/en/insight/Structuring-an-effective-model-risk-management-and-validation-framework.
More information on Milliman insights, products and services related to IFRS 17 can be found at: https://www.milliman.com/en/insurance/ifrs-17